Risk Management 101: Part 5

Sep 26, 2023 | Uncategorized

Basis

By: Devin Patton

“Nobody has ever been able to explain to me what Basis actually is.”
 
This is a direct quote from a lifelong farmer who also happens to be my uncle here in Oregon. The more I talk to farmers, PNW wheat farmers especially, the more I find that this is common.

Here is the answer: “Basis is simply the difference between local cash prices and the futures price at the CME”. (Agweb)
 
Basis is a single number description of the price spread between your local cash bid and the related futures market. When you are building a marketing plan, understanding Basis is critical.

Depending on where you are your cash bids may be Basis bids. Meaning that the bid may be shown as –30 basis December for Corn. In that scenario, the cash bid is whatever December corn futures are trading at minus 30 cents.

The Basis number changes depending on the buyers need for grain in the timeframe for the bid. Whether that is the immediate delivery bid or a bid a few months away. As a hedger you are trading the Basis. When you take a hedge position you have priced those bushels via futures and your only risk is the move in Basis.
 
Example: November Soybeans are at 1360 (as of this writing) and the Current CHS Mankato Soybean bid is minus 25 cents, or 25 under.
 
You enter a short hedge at 1360 November soybean futures instead of making a forward cash sale at 1335 (25 cents less than futures). Then you look at that Basis number, and when it makes a strong move, you make the cash sale and lift your hedge.

The risk is that the Basis bid could become weaker, but the range is much smaller than the futures price range. Once you have bushels hedged, you can only gain or lose on the Basis… this is why hedgers are “Basis Traders”.
 
Every grain buyer has their own Basis for their own supply/demand and freight cost reasons. You must know what “normal” is for your buyers so you know when the Basis is giving an opportunity.

When your Basis is historically “weak” and you need to make a sale, locking in the futures via hedge or a HTA (Hedge-to-Arrive) is the best move. If Basis is historically strong and you see reasons for the futures to rally before delivering, you can ask about a “Basis contract” whereby you lock in the strong basis and wait for the futures to make a strong move.
 
A lot of money is left on the table by farmers who haven’t taken the time to understand what Basis is and why it moves. It is worth your time and effort to research and learn.

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